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40 Minute BriefingDomestic reform:
The first 100 days of the new regimeJonathan Herbst - PartnerKatie Stephen - ConsultantSonya Zywko - Senior Associate
Norton Rose Fulbright LLP
3 July 2013
Domestic reform: The first 100 days of the new regime
Today’s agenda
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• What happened to the Handbook?• The new philosophy: How the FCA is using the new threshold
conditions and objectives• The end of certainty?
– Themed visits– Events driven work
• The world of enforcement
Nuts and bolts: What happened to the Handbook?
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• Minimalist approach: Made sense given the timescales• Approach taken by the FSA prior to cut-over:
– Designate provisions to be carried forward in the new regime– Make changes to certain provisions that did not involve policy changes– Make more substantive changes to align the new Handbooks with the
provisions of the Financial Services Act 2012
• FSA statutory obligation under section 155 FSMA to consult on changes: Several consultation papers published in particular CP12/26 concerning changes to approved persons regime
• Final changes to the Handbook set out in PS13/5
Domestic reform: The first 100 days of the new regime
4 Domestic reform: The first 100 days of the new regime
Nuts and bolts: What happened to the Handbook?• At cut-over FSA Handbook split into FCA and PRA Handbooks:
Note a combined view can be found on FCA website• Interpretation of both Handbooks:
– Purposive interpretation of the rules– If Handbook provision goes beyond the FCA’s or PRA’s powers or
responsibilities, it is to be interpreted as applied by that regulator to the extent of that regulator’s powers and regulatory responsibilities only
The evolution of the new Handbooks
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• FCA and PRA can amend their Handbooks subject to public consultation: Sections 138I and 138J FSMA
• PRA will conduct a review of its Handbook and intends to replace it with a rulebook: – Unclear at the moment how much the rulebook will differ from the Handbook – But guidance material in the rulebook will be strictly limited and other types of
material (e.g. procedure manuals and information on how the PRA will act) will be published separately
– Important to bear in mind the PRA Approach document: Firms expected not to merely meet the letter of the rules nor game them but maintain sight of the overriding principle of their safety and soundness and act accordingly
Domestic reform: The first 100 days of the new regime
6 Domestic reform: The first 100 days of the new regime
The evolution of the new Handbooks• FCA will be reviewing the way it presents rules and guidance:
– Journey to FCA confirms that FCA is reviewing the way that non-Handbook guidance (e.g. letters to firms) can be used as an effective tool for firms: A major issue over the last few years
• Financial Services Act 2012 provides for the FCA and PRA to make threshold condition codes:– Not published so far but FCA has COND and PRA has set out information in its
Approach documents
The new philosophy: The twin pillars
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• Regulatory objectives:– A lot of work within FCA on competition objective: Competition within financial
services in interests of consumers in regulated financial services and markets– Must insofar as possible advance consumer protection and integrity objective to
promote effective competition– Unclear yet how policy will be shaped in this area but questions already much
more focussed for firms on competition issues– Note also the distinction between this and competitiveness of the UK: Now
there is just a sustainable growth have regard to– Innovation is a discretionary have regard to as part of the competition objective
Domestic reform: The first 100 days of the new regime
8 Domestic reform: The first 100 days of the new regime
The new philosophy: The twin pillars • Threshold conditions:
– FCA threshold conditions for FCA authorised firms: Effective supervision, appropriate resources and business model threshold conditions being used to the full
– FCA threshold conditions for PRA authorised firms: Effective supervision and appropriate non-financial resources and business model
– Key point is the breakdown of the compliance versus commercial distinction in the new world
– Ties closely into forward looking regulatory intervention and product regulation
Domestic reform: The first 100 days of the new regime
A further word on effective supervision
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• FCA effective supervision threshold condition:– New threshold condition encompassing previous FSA close links condition– Covers all circumstances including the nature and complexity of the firm’s
regulated activities, the complexity of its products and the way in which the business is organised
• Appropriate non-financial resources:– PRA solely responsible for assessing dual regulated firm’s financial resources
under its prudent conduct threshold conditions– Appropriate interpreted as meaning sufficient in terms of quantity, quality and
availability– Includes any systems, controls, plans or policies that the firm maintains, any
information that the person holds and the human resources that the firm has available
– Assess whether firm able to comply with SYSC and other applicable systems and controls requirements
– FCA may consider the impact of other members of the firm’s group on the adequacy of its resources
Domestic reform: The first 100 days of the new regime10
Business model analysisFCA
• FCA will look at a firm’s business model to ensure it meets the needs of consumers when it considers authorising it
• Firms applying for authorisation or to vary their permissions will be assessed against FCA threshold conditions, one of which is the Business Model Threshold Condition (BMTC)
• BMTC will demonstrate the importance that the FCA will place on a firm’s ability to put forward an appropriate, viable and sustainable business model, given the nature and scale of business that they intend to carry out
• FCA will expect firms to:
– Demonstrate adequate contingency planning in their business model
– Make clear how their business model meets the needs of the client
– Provide clear information, with evidence of how they will meet BMTC
• FCA will recommend refusal at an early stage where it is not satisfied that a firm meets, or will continue to meet, BMTC
• FCA is consulting on how it will apply BMTC
PRA
• PRA’s supervisory approach will include business model analysis of firms it regulates
• The analysis will include an assessment of where and how a firm makes money, the risks it takes in so doing, and how it funds itself. Firms will be assessed at the level of the firm or the sector as appropriate
• PRA will aim to understand a business model’s sustainability and vulnerabilities. Vulnerabilities might include:
– Unsustainable expectations of growth
– Heavy reliance on an inflexible structure of net interest income, with consequent exposure to a low interest rate environment
– Concentrated funding sources which may dry up in stressed circumstances
– Significant consequences following a change in credit rating
• For those firms posing greater risk to the stability of the financial system, the analysis will be more detailed. It will include a review of the drivers of profitability, risk appetite, performance targets and underlying assumptions, and a firm’s own forecasts and their plausibility
• If the PRA believes that mitigating measures alone cannot adequately reduce material risks to the safety and soundness of the firm, it will require the firm to change its business model
Domestic reform: The first 100 days of the new regime
The end of certainty? - Themed visits
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· The key message:– Certainty on the cycle of visits and communications has gone: FCA will be pre-
emptive and tough and firms can expect much more challenge· Reminder of FCA firm categorisation:– C1 and C2 to be fixed portfolio firms with a nominated supervisor– C3 and C4 to be flexible portfolio supervised by a team of sector specialists and
no nominated supervisor: A lot of firms have or are losing their supervisor· The FCA three pillar supervisory approach: – Firm Systematic Framework (FSF), event-driven work and issues and products– FSF assesses the firm’s conduct risk and aims to answer the question: Are the
interests of customers and market integrity at the heart of how the firm is run?– Fewer supervisors allocated to specific firms means more flexibility to assign
resources to pillars 2 and 3 – Issues and products: Sector risk assessment which provides an assessment of
the conduct risks across a sector– The reality of sector risk assessment is that firms without supervisors never
know when the theme arc light may shine on them
Domestic reform: The first 100 days of the new regime
Practical reality of themed visits
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• Regulator will identify an area about which it has concerns or wishes to find out more: Areas may be identified by supervisors, policy work, or by looking at trends in complaints
• Objectives of a themed visit: Identify good practice, address identified risks or determine the scale of risks identified from intelligence or surveillance
• In reality, tight timing for documentation requests and visit shortly after that: Appears designed to stop “creation” of documentation
• Message is to do proper trend analysis and have documentation and people ready at any time: Dawn raid prep is a good comparator
13 Domestic reform: The first 100 days of the new regime
Practical reality of themed visits• Key issue for firms is to avoid 166 or disciplinary action:
– Much more commercial focus with linkage to the new business model threshold condition: Firms need to be clear how their business model meets the needs of clients and customers
– The focus on approved persons– Already seen results in investment managers ABC/AML, conflicts and transition
management visits• A new NRF product: The Complete Themed Visit Response
Domestic reform: The first 100 days of the new regime
The twist in the tail: Lessons from event driven work
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• The official position:– SUP 1A.3.4 definition: Dealing with problems that are emerging or have
crystallised, and securing customer redress or other remedial work (e.g. to secure the integrity of the market) where necessary
– Covers everything from deals where there has been a problem to whistleblowing allegations to spikes in reported complaints at a firm
• FCA Business Plan 2013/14:– Delivering consumer protection FCA moving from a reactive approach to a more
proactive one– Complex Event-Driven Crystallisation Team aims to resolve issues quickly and
decisively• The reality:
– Vital for firms to consider Principle 11 and breach notifications carefully as they may trigger referral to crystallisation team
– A firm without a supervisor may suddenly find itself the subject of a lot of attention
– Even for firms with supervisors the old world in which the supervisor was in control is largely gone: Other forces at work within FCA which have key input on outcomes
Domestic reform: The first 100 days of the new regime15
Enforcement: 100 Days
• Priorities• Penalties• Process• Publication
Domestic reform: The first 100 days of the new regime17
So what is new? The people?
FSA Director of Enforcement Tracey McDermott
FCA Director of Enforcement Tracey McDermott
Domestic reform: The first 100 days of the new regime19
FCA Priorities 2013/14
Themes
• Focus on consumers• Culture• Principles• Credible deterrence• Senior management
Hot topics
• LIBOR• Market abuse• Unauthorised business• Financial crime controls• Mis-selling• Client money and assets• Complaints handling
20 Domestic reform: The first 100 days of the new regime
FCA Priorities 2013/14
Thematic reviews feed into enforcement
• Banks’ control of financial crime risks in trade finance• Mobile phone insurance• Motor legal expenses insurance• Claims handling• Product governance• Mortgage arrears handling procedures
21 Domestic reform: The first 100 days of the new regime
Senior management• Credible deterrence:
– 55 individuals (over £5m fines, 43 prohibitions and 13 criminal convictions)– 38 firms (£418m fines)
• Knowingly concerned (Cummings, Thiam)• No comfort in a crowd (Thiam)• If in doubt, disclose:
– to the regulator (Thiam, Final Notice, Censure)– to the board (Burns, Decision Notice, £154,800)– to shareholders (Willford, Decision Notice £100,000)
22 Domestic reform: The first 100 days of the new regime
Mis-selling• Drivers of behaviour• Product focus• Actual or potential:
– Sesame £6,031,200, Principles 3 and 9– JP Morgan £3,076,200, Principle 3
Domestic reform: The first 100 days of the new regime23
Client Assets and Complaints Handling
Client Assets• XCap: £120,000, Principles
3 and 10 and CASS• Horn Express: Censure
(£136,687), Payment Services Regulations
Complaints Handling• UBS: £9.45m, mis-selling
and complaints handling• Lloyds: £4.315m, PPI
complaints handling• Co-op: £113,300, PPI
complaints handling
24 Domestic reform: The first 100 days of the new regime
PenaltiesMarch 2010 – new penalty regime• When the new regime applies:
– “Gravamen of misconduct”– Majority of misconduct
• Revenue not always indicative of harm:– Client asset cases: daily average of balances– Listing rules cases: average market capitalisation – Forecasts
• Lead time
Process
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• Decision Notice reasons• Challenging the regulator• PRA
Domestic reform: The first 100 days of the new regime
26 Domestic reform: The first 100 days of the new regime
Publication of Decision NoticesArch Cru: September 2012• Grounds:
– Serious reputational harm– Risk to families from disgruntled investors– Adverse effect on civil proceedings
• But…– Lack of evidence– Press comment– Court papers publicly available
• No “cogent evidence of disproportionate damage”
27 Domestic reform: The first 100 days of the new regime
Publication of Decision NoticesBurns: May 2013• “Possibility” of severe damage vs “significant likelihood”• Burden not discharged due to:
– Uncertainty of future business– Prospects of revival– Financial impact “not such to leave her insolvent or destitute”
• Cogent evidence needed to outweigh strong presumption that publication should be permitted
28 Domestic reform: The first 100 days of the new regime
Publication of Decision NoticesChristopher Willford: June 2013• Judicial Review• Private at first instance• Not at Court of Appeal• Public interest in open justice• Judicial review brings matter into public forum
Domestic reform: The first 100 days of the new regime29
Publication of Warning Notices
Background• “Greater and earlier
transparency”• RDC to decide if publish:
CP12/37• How power will be used:
CP13/8
What will be published?• s.391(1)(c) “appropriate”• Statement• Caveats• Not sanction
Domestic reform: The first 100 days of the new regime30
Publication of Warning Notices
Process• 14 days• RDC decision
Unfairness• “Clear and convincing
evidence…suffer a disproportionate level of damage” e.g.– materially affect physical or
mental health– disproportionate loss of income
or livelihood– prejudice criminal proceedings
31 Domestic reform: The first 100 days of the new regime
Enforcement Summary • Different face, different focus?• “Tough and meaningful action”• Earlier public exposure
32 Domestic reform: The first 100 days of the new regime
Contact details
Jonathan Herbst
Partner
Norton Rose Fulbright LLP
Solicitor, qualified in England & Wales
+44 20 7444 3166
Peter Snowdon
Partner
Norton Rose Fulbright LLP
Solicitor, qualified in England & Wales
+44 20 7444 3912
Katie Stephen
Consultant
Norton Rose Fulbright LLP
Solicitor, qualified in England & Wales
+44 20 7444 2431
Sonya Zywko
Senior Associate
Norton Rose Fulbright LLP
Solicitor Advocate, qualified in England & Wales
+44 20 7444 2160